Flexible Budgets and Overhead Analysis · 2015-01-16 · Variable Overhead Variances – Example ColaCo’s actual production for the period required 3,200 standard machine hours

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McGraw-Hill /Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Flexible Budgets and Overhead Analysis

Management Accounting Lecture 15 (Chapter 9)


Today’s Agenda

n  What is a Flexible Budget n  Flexible versus Static Budget

n  Shortcomings of Static Budgets

n  Advantages of Flexible Budgets

n  Building a Flexible Budget

n  Variance Analysis


Static Budgets and Performance Reports

Static budgets are prepared for a single, planned level of activity.

Performance evaluation is difficult when actual activity

differs from the planned level of activity.

Hmm! Comparing static budgets with actual costs is like comparing apples

and oranges.


Flexible Budgets

Let’s look at a Specific Example.

Flexible Budget

May be prepared for any activity level within the relevant range.

Show costs that should have been incurred at the actual level of activity, enabling “apples to apples” cost comparisons.

Reveal variances related to cost control.

Improve performance evaluation.


CheeseCo Static Actual

Budget Results Variances

Machine hours 10,000

Variable costs Indirect labor 40,000$ Indirect materials 30,000 Power 5,000

Fixed costs Depreciation 12,000 Insurance 2,000

Total overhead costs 89,000$



CheeseCo Static Actual

Budget Results Variances

Machine hours 10,000 8,000

Variable costs Indirect labor 40,000$ 34,000$ Indirect materials 30,000 25,500 Power 5,000 3,800

Fixed costs Depreciation 12,000 12,000 Insurance 2,000 2,050

Total overhead costs 89,000$ 77,350$


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Static ActualBudget Results Variances

Machine hours 10,000 8,000 2,000 U

Variable costs Indirect labor 40,000$ 34,000$ $6,000 F Indirect materials 30,000 25,500 4,500 F Power 5,000 3,800 1,200 F

Fixed costs Depreciation 12,000 12,000 0 Insurance 2,000 2,050 50 U

Total overhead costs 89,000$ 77,350$ $11,650 F

U = Unfavorable variance CheeseCo was unable to achieve

the budgeted level of activity.

CheeseCo




Machine hours 10,000 8,000 2,000 U




CheeseCo

F = Favorable variance that occurs when actual costs are less than budgeted costs.




Machine hours 10,000 8,000 2,000 U




Since cost variances are favorable, have we done a good job controlling costs?

CheeseCo



I don’t think I can answer the question using a static budget.

Actual activity is below budgeted activity.

So, shouldn’t variable costs be lower if actual activity

is lower?




" The relevant question is . . . “How much of the favorable cost variance is due to lower activity, and how much is due to good cost control?”

" To answer the question, we must the budget to the actual level of activity.


Preparing a Flexible Budget

To a budget we need to know that: n Total variable costs change

in direct proportion to changes in activity.

n Total fixed costs remain unchanged within the relevant range. Fixed

Variable

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Give me a budget.


Cost Total Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours

Machine hours 8,000 10,000 12,000

Variable costs Indirect labor 4.00$ Indirect materials 3.00 Power 0.50 Total variable cost 7.50$

Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs

Flexible Budgets


Fixed costs are expressed as a total amount.

Variable costs are expressed as a constant amount per hour.

$40,000 ÷ 10,000 hours is $4.00 per hour.

CheeseCo



Machine hours 8,000 10,000 12,000

Variable costs Indirect labor 4.00$ 32,000$ Indirect materials 3.00 24,000 Power 0.50 4,000 Total variable cost 7.50$ 60,000$

Fixed costs Depreciation 12,000$ Insurance 2,000 Total fixed costTotal overhead costs

Flexible Budgets


$4.00 per hour × 8,000 hours = $32,000

CheeseCo



CheeseCo Cost Total

Formula Fixed 8,000 10,000 12,000per Hour Cost Hours Hours Hours

Machine hours 8,000 10,000 12,000


Fixed costs Depreciation 12,000$ 12,000$ Insurance 2,000 2,000 Total fixed cost 14,000$ Total overhead costs 74,000$

Flexible Budgets



Machine hours 8,000 10,000 12,000

Variable costs Indirect labor 4.00$ 32,000$ 40,000$ Indirect materials 3.00 24,000 30,000 Power 0.50 4,000 5,000 Total variable cost 7.50$ 60,000$ 75,000$

Fixed costs Depreciation 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ ?

Flexible Budgets


Total fixed costs do not change in

the relevant range.

CheeseCo




Machine hours 8,000 10,000 12,000

Variable costs Indirect labor 4.00$ 32,000$ 40,000$ 48,000$ Indirect materials 3.00 24,000 30,000 36,000 Power 0.50 4,000 5,000 6,000 Total variable cost 7.50$ 60,000$ 75,000$ 90,000$

Fixed costs Depreciation 12,000$ 12,000$ 12,000$ 12,000$ Insurance 2,000 2,000 2,000 2,000 Total fixed cost 14,000$ 14,000$ 14,000$ Total overhead costs 74,000$ 89,000$ 104,000$

Flexible Budgets

CheeseCo

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Let’s use a

budget for our performance

report.

Flexible Budget Performance Report


Cost Total Formula Fixed Flexible Actualper Hour Cost Budget Results Variances

Machine hours 8,000 8,000 0



CheeseCo A flexible budget is

prepared for the same activity level

(8,000 hours) as actually achieved.





Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect materials 3.00 25,500 Power 0.50 3,800 Total variable cost 7.50$ 63,300$


CheeseCo





Variable costs Indirect labor 4.00$ 32,000$ 34,000$ $ 2,000 U Indirect materials 3.00 24,000 25,500 1,500 U Power 0.50 4,000 3,800 200 FTotal variable cost 7.50$ 60,000$ 63,300$ $ 3,300 U

Fixed costs Depreciation 12,000$ 12,000$ 12,000$ $ 0 Insurance 2,000 2,000 2,050 50 UTotal fixed cost 14,000$ 14,050$ 50 UTotal overhead costs 74,000$ 77,350$ $ 3,350 U

CheeseCo Flexible Budget Performance Report



Remember the question: “How much of the total variance is due to lower activity and how much is due to cost control?”



Machine hours 10,000 8,000 2,000 U




Static Budgets and Performance How much of the $11,650 favorable variance is due to lower activity and how much is due to cost control?

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Difference between original static budget and actual overhead = $11,650 F.

Overhead Variance Analysis Static Actual

Overhead OverheadBudget at at

10,000 Hours 8,000 Hours

89,000$ 77,350$

Let’s insert the flexible budget for

8,000 hours here.



Overhead Variance Analysis

This $15,000 F variance is due to lower activity.

Activity

This $3,350 U variance is due

to poor cost control.

Cost control

Static Flexible ActualOverhead Overhead OverheadBudget at Budget at at

10,000 Hours 8,000 Hours 8,000 Hours

89,000$ 74,000$ 77,350$



The Measure of Activity– A Critical Choice

Three important factors in selecting an

activity base for an overhead flexible budget

Activity base and variable overhead

should be causally related.

Activity base should not be expressed

in dollars or other currency.

Activity base should be simple and

easily understood.


Variable Overhead Variances – A Closer Look

If flexible budget is based on actual hours

If flexible budget is based on

standard hours

Only a spending variance can be

computed.

Both spending and efficiency

variances can be computed.


Variable Overhead Variances – Example

ColaCo’s actual production for the period required 3,200 standard machine hours. Actual variable overhead incurred for the

period was $6,740. Actual machine hours worked were 3,300. The standard variable overhead cost per machine hour is $2.00.

Compute the variable overhead spending variance first using actual hours. Then use

standard hours allowed to calculate the variable overhead efficiency variance.


Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours

AH × SR AH × AR

Spending Variance

Spending variance = AH(AR – SR)

Variable Overhead Variances

AH = Actual hours AR = Actual variable overhead rate SR = Standard variable overhead rate

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Actual Flexible Budget Variable for Variable Overhead Overhead at Incurred Actual Hours

3,300 hours ×

$2.00 per hour = $6,600 $6,740

Spending Variance = $140 unfavorable

Variable Overhead Variances – Example


Variable Overhead Variances – A Closer Look

Spending Variance

Results from paying more or less than

expected for overhead items and

from excessive usage of overhead

items.

Now, let’s use the standard hours

allowed, along with the actual hours, to

compute the efficiency variance.


Review

n  What is a Flexible Budget n  Flexible versus Static Budget

n  Shortcomings of Static Budgets

n  Advantages of Flexible Budgets

n  Building a Flexible Budget

n  Variance Analysis


Tutorial

n  Review of today’s and last weeks lecture

n  Questions to be provided n  C n  D


Exercise C (Question)

145. Flick Company uses a standard cost system in which manufacturing overhead is applied to units of product on the basis of standard direct labor-hours. The company's total budgeted variable and fixed manufacturing overhead costs at the denominator level of activity are $20,000 for variable overhead and $30,000 for fixed overhead. The predetermined overhead rate, including both fixed and variable components, is $2.50 per direct labor-hour. The standards call for two direct labor-hours per unit of output produced. Last year, the company produced 11,500 units of product and worked 22,000 direct labor-hours. Actual costs were $22,500 for variable overhead and $31,000 for fixed overhead. Required: a. What is the denominator level of activity? b. What were the standard hours allowed for the output last year? c. What was the variable overhead spending variance? d. What was the variable overhead efficiency variance? e. What was the fixed overhead budget variance? f. What was the fixed overhead volume variance?


Exercise D (Question) Chapter 009, Flexible Budgets and Overhead Analysis

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153. Creger Corporation, which makes landing gears, has provided the following data for a recent month:

Required: Determine the total variance, the spending variance, and the efficiency variance for the variable overhead item supplies cost that would appear on the company's variable overhead performance report. Show your work!

AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Reporting Learning Objective: 4 Level: Easy

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Flexible Budgets and Overhead Analysis · 2015-01-16 · Variable Overhead Variances – Example ColaCo’s actual production for the period required 3,200 standard machine hours